Rating cut piles pressure on Spain to seek aid

Paul Day, Rodrigo De Miguel

5 IN. DI LETTURA

MADRID (Reuters) - Spain faced renewed pressure to take the politically humiliating step of seeking sovereign aid on Thursday after a credit agency cut its rating for the government’s debt to near junk.

Standard and Poor’s said recession was limiting Spain’s options on policy and said Madrid’s delay in asking for aid could drag on the new rating, which it kept on negative outlook - indicating another cut is in prospect.

Another headache for the government came with data showing consumer prices rose at their fastest pace in 16 months in September, further depressing demand among cash-strapped consumers.

“We expect the current situation to continue to run until either market or political pressures become more acute,” U.S. investment bank JP Morgan said in a note to clients. “The promise of ECB action may be holding back both sorts of pressure in the near-term, and there is little evidence to suggest that either will necessarily reappear over the next few weeks.”

The European Central Bank’s plan to buy the bonds of struggling governments has raised hopes of an end to the most acute phase of the euro zone’s crisis. Spain’s delay in asking formally for such aid is steadily undermining such hopes.

Prime Minister Mariano Rajoy, who has said he will only make an aid request decision when he had all the details, is thought to be waiting for regional elections October 21 and, if the ECB effect keeps debt costs down, he may delay a decision further.

While neither Rajoy or the euro zone’s paymaster Germany seem keen for Spain to dive in to a rescue plan, further market pressure or a sovereign downgrade to junk would hasten the process, economists say.

“In the short term we suspect that the noise and column inches generated by the S&P downgrade will be disproportionate to its impact,” Citi said in a note.

“But the longer term impact could be very significant if the market sees the trajectory towards Spain’s eventual exclusion from (investment grade) indices as inevitable.”

Secretary of State for the Economy Fernando Jimenez Latorre reiterated that Madrid was still considering whether to apply for aid.

S&P’s action brought it in line with peer Moody’s, which also has Spain on the verge of losing its investment grade and is due to complete a review of that rating this month.

RISING YIELDS

Spanish borrowing costs have fallen well back from levels above 7 percent that triggered bailouts for other euro zone states, but the yield on its 10-year bond rose to nearly 6 percent early on Thursday before dipping back to 5.82 percent, down on the day.

The yield remains around 180 basis points below the levels it reached before the ECB first suggested it would start a bond-buying program.

Improved funding conditions over the last month have helped Spanish corporates and banks, including Santander (SAN.MC) and BBVA (BBVA.MC), return to markets for funds and reduce reliance on the ECB for funding.

“There has been a window for Spanish companies and banks to tap the bond markets and that has reduced the reliance in September, but it is still too early to talk about a new trend and overall the dependence on the ECB seems high,” said Nuria Alvarez, analyst at Madrid-based Renta 4.

The Treasury plans a private placement of 4.86 billion euros ($6.3 billion) of bonds maturing in 2015, 2016 and 2017 on Thursday to finance part of a fund aimed at reducing financing costs for Spanish regions that have been shut out of markets.

Its efforts to cut back public spending and retrench the budget include a 3-point rise in VAT to 21 percent last month. Data on Thursday, however, showed that drove inflation to 3.4 percent - another burden for households already struggling with unemployment of 25 percent and cuts in pay and benefits.

The resulting grim growth outlook is undermining Rajoy’s plans to cut the deficit from 8.9 percent of national output to 4.5 percent next year. Economists worry that higher inflation will also lead to higher rises in inflation-indexed pensions that could further undermine the push.

“Indexation of pensions might challenge fiscal targets, but it is not the only risk. We are also concerned about lower growth and decline in employment,” S&P’s economists told Reuters in an email on Thursday.

IMF chief Christine Lagarde suggested on Thursday that European governments should take more time with cutbacks to reduce deficits, but Deputy Prime Minister Soraya Saenz de Santamaria said Madrid would stick to its existing timetable.